The Disappearing Defined Benefit Pension and Its Potential Impact on the Retirement Incomes of Baby Boomers

Article excerpt

This article uses a microsimulation model to estimate how freezing all remaining private-sector and one-third of all public-sector defined benefit (DB) pension plans over the next 5 years would affect retirement incomes of baby boomers. If frozen plans were supplemented with new or enhanced defined contribution (DC) retirement plans, there would be more losers than winners, and average family incomes would decline. The decline in family income would be much larger for last-wave boomers born from 1961 through 1965 than for those born from 1946 through 1950, because younger boomers are more likely to have their DB pensions frozen with relatively little job tenure. Higher DC accruals would raise retirement incomes for some families by more than their lost DB benefits. But about 26 percent of last-wave boomers would have lower family incomes at age 67, and only 11 percent would see their income increase.

Introduction

The percentage of workers covered by a traditional defined benefit (DB) pension plan that pays a lifetime annuity, often based on years of service and final salary, has been steadily declining over the past 25? years. From 1980 through 2008, the proportion of private wage and salary workers participating in DB pension plans fell from 38? percent to 20? percent (Bureau of Labor Statistics 2008; Department of Labor 2002). In contrast, the percentage of workers covered by a defined contribution (DC) pension plan-that is, an investment account established and often subsidized by employers, but owned and controlled by employees-has been increasing over time. From 1980 through 2008, the proportion of private wage and salary workers participating in only DC pension plans increased from 8? percent to 31? percent (Bureau of Labor Statistics 2008; Department of Labor 2002). More recently, many employers have frozen their DB plans (Government Accountability Office 2008; Munnell and others 2006). Some experts expect that most private-sector plans will be frozen in the next few years and eventually terminated (Aglira 2006; Gebhardtsbauer 2006; McKinsey & Company 2007). Under the typical DB plan freeze, current participants will receive retirement benefits based on their accruals up to the date of the freeze, but will not accumulate any additional benefits; new employees will not be covered. Instead, employers will either establish new DC plans or increase contributions to existing DC plans.

These trends threaten to shake up the American retirement system as we know it because of vast differences between DB and DC pension plans, including differences in coverage rates within a firm, timing of accruals, investment and labor market risks, forms of payout, and effects on work incentives and labor mobility. DB pensions are tied to employers who, consequently, bear the responsibility for ensuring that employees receive pension benefits. In contrast, DC retirement assets are owned by employees who, therefore, bear the responsibility for their own financial security.

This article simulates how the shift from DB to DC pensions might affect the distribution of retirement income among boomers under two different pension scenarios: one that maintains current DB pensions, and one that freezes all remaining DB plans in addition to a third of all state and local plans over the next 5? years. The analysis uses the Social Security Administration's (SSA's) Modeling Income in the Near Term (MINT) microsimulation model to describe the potential impact of the pension shift on boomers at age? 67. The article examines both changes in retirement income and the numbers of winners and losers, and it compares these outcomes among individuals grouped by sex, educational attainment, marital status, race/ethnicity, years of paid employment, and quintiles of lifetime earnings and retirement income. Of principal concern is whether income from increased DC plan coverage will compensate for the loss of DB plan benefits.

Background

There are two general types of pensions: DC plans and traditional DB plans. …